What you need to know about your debt-to-income ratio

13 February 2018

Understand the number lenders use to predict your ability to repay a loan — and how to swing it in your favor.

Your credit score isn’t the only thing you need to worry about when applying for a new credit card or loan. Having a good debt-to-income ratio (DTI) is also key to qualifying, and understanding it can set you on the path to getting a better interest rate or loan terms.

Read on to find out what this mighty number is, how to calculate your DTI and what you can do to lower it.

What do you want to learn about first?

What is a debt-to-income ratio?

A debt-to-income ratio is the amount of debt repayments you make each month divided by your income. Lenders use your DTI as one way to make sure you’re in a position to afford to repay a new loan.

Typically, underwriters figure out your DTI themselves. But knowing your ratio before you apply can help you tell if it’s a good time to apply for a loan or credit card. If your score is too high, you might want to consider paying off some debt first to avoid high rates or getting rejected.

Defining debt and income

To calculate your DTI, you first need to know what counts as debt and what counts as income.

What counts as debt?

Debt includes your regular monthly repayments on personal loans, student loans, car loans, mortgages or any other type of loan. Your monthly minimum credit card payments also count as debt, as do unpaid bills sent to collection agencies.

You might think that monthly bills besides credit card and loan payments should count. But here’s why they don’t: With these bills, you’re paying for a service, typically one that’s consistent.

What counts as income?

The income DTI refers to is your gross monthly income — that is, your income before taxes or deductions are subtracted. Income includes your salary, but it’s not limited to just what you bring in each month.

Tips or bonuses, pensions, retirement account distributions, Social Security benefits, alimony and child support all count as income too. Think of income as any kind of money that’s coming in that you don’t have to repay.

What doesn’t count as income?

In a word: Loans. Borrowed money doesn’t count as income because it’s money you have to pay back — in other words, it’s actually debt.

You also can’t include income that you don’t have reasonable access to when calculating your DTI. Say you’re a student and still count as a dependent when your parents file for taxes. Even if you get most of your money from your parents, you can’t count their income as yours when applying for a credit card or student loan.

1. Anita’s a recent college graduate who wants to apply for a credit card to improve her credit score. She makes $48,000 a year before taxes as a full-time project manager at a local nonprofit. Her only debt is student loan repayments. Figuring out her DTI is pretty simple:

Total debt

$400 a month in student loan repayments

Total income

$4,000 before taxes

Debt-to-income ratio

400/4,000 = 0.1 or 10%

2. Frank wants to apply for a personal loan to help cover the cost of his son’s wedding, but his situation is a bit more complicated than Anita’s. He’s 66 years old, makes $75,000 a year and receives monthly Social Security benefits. He also has a mortgage, a car loan and two credit cards that pays off each month.Here’s how Frank calculates his DTI:

What’s considered a good DTI?

The lower the better, naturally. More specifically, a DTI of 35% or below is generally considered good – though you might not qualify for a loan with a DTI that’s above 43%.

Why 43%? Lenders came up with this number as a result mortgage-risk studies that analyzed the type of borrowers who are most likely to have trouble making payments — and therefore default on their loans.

Your DTI is a factor lenders consider when determining the rates and terms of your loan. In general, you’re more likely to get a good rate with a lower DTI.

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Your lender didn’t ask about your debt or income? Its offer could be a scam.

If your lender doesn’t want to know how much you owe or earn, it’s just one sign that it might be predatory.

If you come across a lender that markets itself in this way, make sure it’s legit before signing on. Read online reviews, check out its accreditations and confirm that it’s not on lists of lenders to avoid, like those compiled by the Consumer Financial Protection Bureau and state consumer protection agencies. Take a look at its ratings with the Better Business Bureau and take heed of any complaints.

My DTI is too high. How do I lower it?

Americans’ debt burden has been high for a while now: A recent Federal Reserve report estimates the average American household carries $137,063 in debt. You’re probably not alone if your debt-to-income ratio is above or close to the 43% cutoff.

Here are some ways you can tamp down your DTI.

Pay off your loans ASAP. Getting rid of even one larger monthly debt expense can make a huge difference in lowering your DTI. Understand your loan’s prepayment policy before making any extra repayments, however. Some come with penalties for paying early, while others require that you follow a specific procedure for successful payoffs.

Creatively boost your income. You don’t necessarily need to take on a second job to make extra money. Bringing in more cash could be as simple as opening up an eBay store, selling old records or writing online reviews.

Rent instead of buying. Renting isn’t always a smarter financial move in general. But when it comes to keeping your DTI low, it could be. That’s because rent doesn’t count as a debt, whereas mortgage payments do.

My personal loan application was declined because of my DTI. What do I do?

If you don’t need that loan right away, consider holding off on reapplying until you’ve taken steps to improve your DTI. Showing that you can repay your loan is one of the most important factors to a reputable lender.

If it’s an emergency, consider applying for a short-term loan, which often comes with more lenient eligibility requirements. But there’s no guarantee you’ll be approved for that either. Even if you are, you could end up with astronomical interest rates that can send you into a debt spiral if you’re unable to make a payment.

Bottom line

Your debt-to-income ratio is an important determining factor in getting a loan, right up there with your credit score. While many lenders calculate your DTI for you, knowing yours can help you figure out the type of loan you can qualify for.

If your DTI is over 43%, consider taking steps to lower it before applying for new credit.

Frequently asked questions

Mortgage applicants need to pay attention to two debt-to-income ratios. The first is called a front-end ratio, which is your potential monthly mortgage repayment divided by your income. In general, you want to keep this ratio under 31%.

The second is called a back-end ratio, which is your total mortgage payment divided by your total income. You can’t qualify if this ratio is higher than 43%.

They might. Unpaid medical bills sent to a collection agency count as debt and can affect your DTI. These bills can also lower your credit score, showing up as a line on your credit report and making it more difficult to get financing.

To qualify for a VA loan, your DTI must be 41% or lower. Servicemembers are allowed to count the money they put toward housing expenses and basic living expenses (like food) as income.

Anna Serio is a writer at finder who specializes in loans. She spent the past five years living in Beirut, where she worked as a news editor and hung out with a lot of cats. She loves to eat, travel and save money.

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